How are cartels formed

The evidences show that cartels often were formed following a period of declining prices, but these price declines were not generally associated with macroeconomic fluctuations. They were the result of increasing competition and market integration. So commission have to be on vigil when there is declining trend in prices and severe competition in market, as these are the situation that form the basis for firms to get together as it is very difficult to get the evidence to prove cartel formation so commission has to be on vigil in advance. The potential profit associated with successful cartelization create a financial rationale for firms to devise means to overcome the short-term incentives to deviate from a cartel agreement; to frustrate entry by new firms; and to prevent detection by competition authority. Some cartels have turned even to govt. policies to achieve their ends; for example, international cartels may employ anti-dumping law, quotas, regulations, or govt. surveillance etc. They also employ a variety of private measures including vertical restraints, or use of a common sales agent, patent pooling, joint venture, and mergers. Here these are additional anticompetitive actions taken by cartels to create barriers to entry through mergers and joint ventures. Why Should Cartels Be Broken Up Cartels are particularly damaging form of anti-competitive activity. Their purpose is to increase prices by removing or reducing competition and allow the businesses to achieve greater profits for less effort to the detriments of consumers and the economy as a whole. As a result they directly affect the purchasers of the goods or services whether they are public or private businesses or individuals. Cartels also have a damaging effect on the wider economy as they remove the incentive for businesses to operate efficiently and to innovate. For the purchasers of their goods or services this means: higher prices poorer quality less or no choice Detecting and taking enforcement action against the businesses involved in cartels is therefore one of commissions main priorities. Economic theory has got two implications for cartels. Theory identifies the incentives to sell above agreed quotas, or below market prices, as a source of instability underlying all cartels. This has implication for how govt. might allocate scarce resources, if one identifies which firms are most likely to be able to overcome the incentive to cheat and direct resources there.

How do international cartels survive? Is such vigorous prosecution necessary, given firms incentive to compete and the increased competitive pressure of global markets? The answer depends on ones view of the stability of cartels, in light of the obstacles they face. Producers form cartels with the goal of increasing profit by restricting supply and raising price. By increasing price, in principle to the price a monopolist would set, the profits received by all firms in the industry are jointly maximized. Creating and maintaining a cartel is not a simple task, however, and cartels face three key challenges. The first is coordination: firms must coordinate their actions, often with limited communication, in order to choose a price and allocate an output target among member firms. Second, cartels must prevent cheating by cartel member firms. The collective interests of all firms are achieved if they restrict output and raise price. But given the price set by the cartel, each firm has an incentive to increase output beyond their allocation. Without enforceable contracts, each firm will do so, undermining the cartel altogether. The tension between the collective and individual interests of firms is represented succinctly in the game. How do firms come to agreement about how to share the reductions in output necessary to increase prices above the competitive level? The first, perhaps obvious,point is that firmsor at least the firms caught colludingseem to need to talk to each other. These conversations often occur at the very highest level of the firm. For many cartels, there are two levels of organization: a high-level group of top executives and general managers, and a working level group of sales managers. The citric acid cartel exemplifies this pattern of development of hierarchical organization. Five citric acid producers fixed prices from approximately July 1991 to June 1995. In order to implement their price-fixing conspiracy, they developed an elaborate hierarchical structure. The senior executives responsible for determining the broad framework of the cartel agreement were nicknamed the masters, while the lower level executives responsible for the day-to-day workings of the cartel were the sherpas. In the overwhelming majority of recent European prosecutions of international cartels, there were biannual meetings of the upper echelon, and in several cases there were quarterly meetings.The bargaining process often begins by focusing on preexisting market divisions, such as geographic or political borders. For certain commodities, however, producers sell globally (or at least in a large number of countries), so that dividing the market along geographic lines is not feasible. In these cases, cartel members set global volume quotas. The vitamin B2 cartel, for example, was organized by using existing market shares to set future global sales quotas.Whether or not they rely on geographical divisions, the vast majority of cartels allocate the largest customers to particular producers. Allocating customers allows cartel members to engage in price discrimination without undermining collusion. For example, in one of the carbon products cartels, large customer accounts were assigned to individual cartel members in order to avoid the difficulty of implementing uniform prices for large customers throughout Europe.Other cartels, such as industrial copper tubes and methylglucamine, used similar strategies of assigning customers to eliminate competition between cartel members.Coordination is an ongoing challenge over the life of any cartel. Negotiations are simpler in a stable industry, with competitors who know each other, understand one anothers technology, and have long-established relationships with particular customers. It is much more challenging where there

has been recent entry or technological change. In such cases a cartel member may want to signal to other members of the cartel its dissatisfaction with its assigned output or market share allocation. One method of sending such a signal is to refuse to abide by the agreement, often precipitating a price war. These bargaining price wars are attempts to redistribute market shares across cartel members, by establishing the new market shares as a starting point for a new cartel bargain. For example, in the lysine case discussed above, ADM entered the market with a new technology and then demanded a one-third share of the cartels global allocation.This was not well received by the incumbent Japanese firms, who were only convinced to cede ADM a large market share by its pursuit of a global price war.The price war provided a meaningful signal to ADMs competitors by demonstrating ADMs ability (and willingness) to produce and sell at low cost. Cartels often begin with pricing agreements and then find that further negotiations are required to achieve the output reductions necessary to maintain the agreed upon price. This is captured in an exchange among members of the lysine cartel. Having agreed to raise prices in late 1991, Ajinomoto and ADM met [in 1993] to restore the relationship between the two companies and begin the process of developing a comprehensive volume agreement. During this meeting, ADM alluded to the importance of a company controlling its sales force in order to maintain high prices, and explained that its sales people have the general tendency to be very competitive and that, unless the producers had very firm control of their sales people,there would be a price-cutting problem. Ajinomoto indicated that everybody now understood it is necessary to adjust supply.Firms expectations about their competitors propensity to cooperate can also have a significant impact on the ease of coming to agreement. Simply put, trust facilitates collusion. Firms expectations may be influenced by previous interaction, interaction in other markets, and cultural similarities or differences. For example, Podolny and Scott Morton find that members of a shipping cartel were likely to accommodate entry by firms of similar social status, but that low social status entrants more often faced a predatory behavior pricing response.Similarly, Van Driel examines cartel formation and stability for four European transportation industries: he concludes that social background and other characteristics of group development that help to construct executives social identity influence the prevalence of collusion. Interestingly for the study of international cartels, he finds that, contrary to his priors, geographic proximity was not strongly related to collusive success. Trust may flow from preexisting cultural ties, but it can also develop as a result of interactions among collusive firms, both those directly relating to collusion and other types of interactions. For example, diamond miners learned to work cooperatively to address collective action problems such as the resolution of property rights, facilitating a century of collusion in the diamond industry. There is remarkably little evidence that linguistic and cultural differences posed insurmountable problems for the EC cases discussed here. Cartels do not come to an agreement once and for all. They are constantly renegotiating their agreement. This is in part because there are external shocks which require that they must the cartel adjust. For example, exchange rate fluctuations can pose significant challenges to international cartels trying to agree on prices and prevent international arbitrage.Cartels also renegotiate their agreements because members change their own behavior in response to the cartel agreement, in ways not always foreseen in prior cartel negotiations. For example, when firms set price and quantity,but make no

agreement regarding investment, cartel members will sometimes increase their investment, leading to over-capacity. This problem of excess competition in areas that are not explicitly agreed upon by the collusive parties is quite pervasive, extending beyond capacity investment to competition in quality, the provision of credit, the absorption of transportation costs, and other nonprice dimensions. For example, the cement cartel included base-point pricing to avoid competition on transportation charges. Experienced cartels address costly non price competition by including additional such restrictions that limit the incentive to compete in a variety of dimensions.